Pound Rally Extends Beyond Reason to Morgan Stanley: Currencies

The pound, which has risen from $1.5130 on April 3, is the best-performer among the 16 most-traded currencies tracked by Bloomberg in the past six months, gaining 7.6 percent against a basket of nine major peers, Bloomberg Correlation-Weighted Indexes show. Photographer: Chris Ratcliffe/Bloomberg

Oct. 3 (Bloomberg) -- The pound’s rally has pushed the
currency to about its highest valuation this year relative to
strategists’ forecasts, suggesting its world-beating gains may
prove unsustainable given the state of the U.K. economy.

Britain’s currency has surged 6.8 percent since April 3 to
$1.6167, erasing its losses for 2013 amid bets that the Bank of
England may tighten monetary policy sooner than anticipated. The
price of sterling exceeds the $1.55 year-end median estimate of
more than 70 strategists in a Bloomberg poll by 7 cents, or
about 3 cents above this year’s average.

“Sterling is starting to look a little more over-extended,” Ian Stannard, the head of European foreign-exchange
strategy at Morgan Stanley in London, said in a Sept. 26 phone
interview. “There are some longer-term risk factors that could
come back and put sterling back under some pressure,” said
Stannard, whose firm predicts the pound will tumble more than 7
percent by the end of this year to $1.50.

While the economy is starting to gain momentum, second-quarter gross domestic product missed analysts’ forecasts last
week, and was more than 3 percentage points below its 2007
highs. The pound is becoming more important as a gauge of the
U.K. recovery as politicians start the long campaign for the
next general election in May 2015.

‘Potholed’ Recovery

Britain’s “road to recovery continues to look potholed,”
David Tinsley, the chief U.K. economist at BNP Paribas SA, which
has a year-end pound forecast of $1.43, wrote in a Sept. 26
report. “Structural underpinnings remain a cause for
fretfulness.”

The pound, which has risen from $1.5130 on April 3, is the
best-performer among the 16 most-traded currencies tracked by
Bloomberg in the past six months, gaining 6.9 percent against a
basket of nine major peers, Bloomberg Correlation-Weighted
Indexes show. It reached a nine-month high of $1.6260 on Oct. 1.

Sterling’s rally gathered pace after a decline in U.K.
unemployment fueled speculation the Bank of England would raise
interest rates before the U.S.

Those bets have since diminished, with the premium
investors get to hold 10-year U.K. gilts instead of Treasuries
narrowing to 10 basis points, from an almost two-year high of 32
on Sept. 18, the day the U.S. Federal Reserve refrained from
paring monetary stimulus. A basis point is 0.01 percentage
point.

‘Think Again’

“If the financial markets are pricing in a sharp rise
because they think in the past, every time the economy’s growing
quickly the bank’s raised interest rates, I think they should
think again,” BOE Chief Economist Spencer Dale said at an event
in London this week. “Our forward guidance says clearly that’s
not the case.”

A drop in real earnings, or wages adjusted for inflation,
will weigh on the U.K. recovery and the pound, according to HSBC
Holdings Plc, which sees the currency at $1.45 by year-end.

Britain’s biggest bank said its measure of average weekly
earnings, less inflation, has been negative since mid-2010 and
fell further in 2013. Consumer-price inflation slowed to 2.7
percent in August, still outpacing the 1 percent wages growth in
the three months through July, official data show.

Economic ‘Headwind’

Real earnings are “going to be a headwind,” Daragh Maher,
a London-based currency strategist at HSBC, said in a Sept. 26
phone interview. “The only thing that could change that would
be if we saw a swifter improvement in the U.K. labor market.”

Prime Minister David Cameron told the Conservatives’ annual
gathering in Manchester, England, yesterday that living
standards can’t be improved without growth, which requires
fiscal austerity to maintain. He was responding to a Sept. 24
pledge by Labour Party leader Ed Miliband to temporarily freeze
gas and electricity prices should he gain power at the election
in 2015.

Both leaders have encouraged the idea that the two main
parties have the biggest policy differences in a generation.

The latest leg of the pound’s rally started after BOE
Governor Mark Carney said Aug. 7 that policy makers plan to hold
the benchmark interest rate at a record-low 0.5 percent until
unemployment falls to 7 percent, which the central bank didn’t
see happening until the fourth quarter of 2016. When the jobless
rate slid to 7.7 percent in the three months through July,
investors became more optimistic about sterling.

Switching Bets

Futures traders are betting the pound will keep rising for
the first time since February, reversing earlier wagers on a
decline, figures from the Washington-based Commodity Futures
Trading Commission show.

The difference in the number of wagers by hedge funds and
other large speculators on a gain in the pound compared with
those on a decline, or net longs, totaled 1,174 contracts on
Sept. 24, compared with net shorts of 6,310 a week earlier,
according to CFTC data.

The reduction in short-pound positions was “brought about
mainly by U.S. dollar weakness,” Peter Kinsella, a senior
foreign-exchange strategist at Commerzbank AG in London, wrote
in a Sept. 27 note to clients.

Commerzbank is the second-most bullish of more than 70
firms surveyed by Bloomberg, predicting the pound will advance
to $1.63 by the end of 2013. Ahmedabad, India-based Vadilal
Forex and Consultancy Services Ltd. is the most optimistic, with
a forecast of $1.65.

Keeping Up

Strategists have been slow to embrace the pound’s rally,
raising the median estimate for its year-end value by less than
3 percent from $1.51 on April 3, Bloomberg data show. As
recently as July 9, forecasts exceeded the currency’s value as
sterling touched $1.4814, the lowest level since June 2010.

A string of less positive economic reports are starting to
change analysts’ minds about the pound’s prospects.

Britain’s economy grew an annualized 1.3 percent in the
second quarter, the government said Sept. 26, falling short of a
1.5 percent forecast in a Bloomberg survey of 26 strategists.

Europe’s third-biggest economy, will grow 1.3 percent this
year and 2 percent in 2014, compared with 1.6 percent and 2.65
percent for the U.S., Bloomberg surveys of economists suggest.

“The market has dismissed the forward guidance” on rates
“and stayed with the data,” Adnan Akant, the New York-based
chief investment officer for foreign-exchange at Fischer Francis
Trees & Watts Inc., which oversees $56 billion, said in a Sept.
26 phone interview. “It’s quite possible the data might not be
as supportive of sterling anymore.”